Bad loans of banks may nearly double to 14.8% in one year under a severe stress scenario compared to 7.5% in September 2020, the Reserve Bank of India said.

The RBI’s projection of gross non-performing assets (GNPAs) under the baseline stress scenario is 13.5%.

The share of restructured standard advances increased, indicating that large borrowers have commenced availing restructuring benefits extended for Covid-19 stressed borrowers potentially veiling the current stress in the system.

"If the macroeconomic environment worsens into a severe stress scenario, the ratio may escalate to 14.8%. These projections are indicative of the possible economic impairment latent in banks’ portfolios,” the RBI said in its biannual financial stability report.

The GNPA ratio of public sector banks could increase to 16.2% by September 2021 from 9.7% in September 2020 under the baseline scenario. For the private sector banks and foreign banks, the GNPA ratio could increase from 4.6% and 2.5% in September 2020 to 7.9% and 5.4% respectively, over the same period, according to the RBI.

In case of a severe stress scenario, public sector banks will feel the tremor more with their GNPA ratio leaping to 17.6% compared to 8.8% projected for private sector banks and 6.5% for foreign banks.

However, the RBI clarified that the results of the stress tests should not be taken as forecasts. “The adverse scenarios used in the macro stress tests were stringent conservative assessments under hypothetical adverse economic conditions so the model outcomes do not amount to forecasts."

According to the RBI, system level capital adequacy ratio (CAR) could drop to 14% in September 2021 from 15.6% in September 2020 under the baseline scenario and to 12.5% under the severe stress scenario.

"The stress test results indicate that four banks may fail to meet the minimum capital level by September 2021 under the baseline scenario, without factoring in any capital infusion by stakeholders. In the severe stress scenario, the number of banks failing to meet the minimum capital level may rise to nine," RBI said. The central bank, however, did not name the banks.

The core common equity Tier I (CET 1) capital ratio of banks may decline to 10.8% in September 2021 from 12.4% a year ago in the baseline scenario and further to 9.7% under the severe stress scenario in September 2021.

"Furthermore, under these conditions, two banks may fail to meet the minimum regulatory CET 1 capital ratio of 5.5% by September 2021 under the baseline scenario; this number may rise to five in the severe stress scenario," RBI said.

With stress tests pointing to a deterioration in asset quality of banks, early identification of impairment and aggressive capitalisation is imperative for supporting credit growth across various sectors alongside pre-emptive strategies for dealing with potential NPAs.

At the aggregate level, however, banks have sufficient capital, even in the severe stress scenario. This could be further supported by capital raising from the market and, in case of public sector banks, infusion by the government. But at the individual level, several banks may fall below the regulatory minimum if stress aggravates to the severe scenario.

“The need of the hour is for banks to assess their respective stress situations and follow it up with measures to raise capital proactively,” the report cautioned.

The decline in the gross NPAs of commercial banks up to September 2020 was aided significantly by the regulatory dispensations extended in response to the Covid-19 pandemic. However, banks improved their provisions. The provision coverage ratio (PCR) of scheduled commercial banks taken together improved across all groups and rose from 66.2% in March 2020 to 72.4 % in September 2020.